Posts filed under “Think Tank”

The GDP report last Friday evinces the folly of US government economic statistics and Wall Street consensus analysis.

Most of the Street heralded the 1% decline in Q2 GDP because it was 0.5 better than consensus – even though the US government admitted in the release that its GDP estimates over the past several years were consistently wrong! So why should the latest report be any more accurate?!?!

We feel compelled to address the scheme of ‘past month lower revisions producing better than expected m/m or q/q results’ even though the aggregate metric is worse than expected. We have incessantly noted and commented on this scam but most of the trading & investing universe elides it.

We will again utilize basic math to illustrate the scam. If Q4 08 GDP was 100 units, and Q1 09 was reported at -5.5% and Q2 09 GDP was expected to be -1.5%, the expectation was for GDP of 100 units minus 5.5% or 94.5 units, minus 1.5% or 93.08 units.

With the revision of Q1 09 GDP to -6.4% the Q1 GDP units become 100 minus 6.4% or 93.6 units. So Q2 is minus 1% or 92.664. Ergo aggregate GDP was worse than expected!!!!

As we warned, lower imports, a sign of economic weakness, contributed a net 1.4% to GDP.

Once again beancounters ‘fooled’ with inflation to produce higher GDP than warranted.

John Williams: The relatively narrower quarterly contraction in the second quarter reflected the impact of greater weakness being thrown back into the first quarter, in revision, and the use of artificially reduced inflation. The implicit price deflator for the second quarter was 0.2% versus a revised 1.9% (was 2.8%) in the first quarter.

Last week we complained that despite records in fiscal stimulus, Fed largesse, nationalization and rigging of markets the best that can be said is the pace of economic decline is slowing.

Despite a 10.9% surge in federal government spending and virtually no inflation adjustment all that beancounters could fabricate (June data is still incomplete) is a 1% ‘official’ decline in GDP.

David Rosenberg echoes our observation: Imagine, government transfers to the household sector exploded at a 33% annual rate, while tax payments imploded at a 33% annual rate and the best we can do is a -1.2% annualized decline in consumer spending in real terms and flat in nominal terms?…In the absence of the fiscal largesse, it is quite conceivable that consumer spending would have shrunk at a 10% annual rate last quarter!”

And, it is not just labour income that is still in deflation mode. Practically all forms of income are deflating from a year ago — interest income is down 4.5%, dividend income is down 23.0% and proprietary income is down 8.0%. The only income that is really going up is the income from Uncle Sam, which is up more than 10.0% and we have reached a point where a record of nearly one-fifth of personal income is being accounted for by paychecks out of Washington…

Even with decades of understated inflation and overstated of GDP, the current economic contraction is the worse since the Great Depression.

The GDP report also shatters the notion that the stock market is omniscient and demonstrates that Wall Street analysis could not discern the worst economic and financial collapse since the Great Recession.

While the US was in recession since at least Q4 2007, most of the Street did not forecast recession. Stocks, most notably the DJTA, missed the worst economic downturn since the Great Depression. As we keep averring, record funny money, lax regulation and smiley-faced fascism has transformed the stock market from a gauge of economic activity into a generator of economic activity.

Another rise in the July manufacturing indexes for both state owned and privately held businesses in China sent Chinese stocks to a fresh 13 month high and has erased the 5% selloff last Wednesday. The July PMI in India was unchanged but remains firmly above 50 at 55.3. In response, copper is at a fresh…Read More

For some reason the lyrics of Electric Light Orchestra’s classic, Livin’ Thing, keep resounding in my head: “You took me, ooh, woah, higher and higher, baby. It’s a livin’ thing … ” Followed by: “It’s a terrible thing to lose … ” But let me get on to the review of the financial markets …

Investors (or should I say “Johnny-come-latelies”?) last week again favored the reflation trade on the back of better-than-expected US earnings announcements and economic data, indicating that the trough of the recession might be behind us, or at least be stabilizing at depressed levels.

Tempering the bullish sentiment, David Rosenberg (Gluskin Sheff & Associates) commented as follows on Friday’s announcement of a 1.0% (quarter on quarter annualized) contraction in Q2′s real GDP: “While we are past the most pronounced part of the downturn, it may still be premature to call for the end of the recession merely because of the prospect of a positive third-quarter GDP result. After all, we saw GDP advance at a 1.5% annual rate in last year’s second quarter, and if memory serves us correctly, the NBER did not subsequently declare the end of the recession. And even if the recession is ending, as we saw in 2002, that does not guarantee a durable rally in risk assets. Sustainability is the key, and it remains the wild card.”

Many global stock market indices reached new highs for the year during the course of the week, and the S&P 500 Index closed in on the roundophobia 1,000 level. Other beneficiaries of investors’ continued interest in risky assets included commodities, oil, gold (rebounding strongly after a midweek sell-off of $24 an ounce), high-yielding currencies and corporate bonds. On the other hand, the US greenback remained out of favor and the Dollar Index closed the week at its lowest level for the year as investors shunned safe-haven assets.

The past week’s performance of the major asset classes is summarized by the chart below – a set of numbers that again indicates investors’ increased risk appetite. In the case of government bonds, a lukewarm response to the US GDP report took the edge off a poor response to the massive issuance of paper by the Treasury.

A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below. As the second-quarter corporate results in the US came in thick and fast, the American and other markets extended their rallies to three straight weeks in most instances. As a matter of fact, if not for the down week of the Dublin ISEQ Index, the entire table would have been green. But then again, “green shoots” seem to be frowned upon by many pundits.

The MSCI World Index (+1.7%) and MSCI Emerging Markets Index (+2.5%) both made headway last week to take the year-to-date gains to +13.5% and an imposing +48.8% respectively.

As seen from the table, July was a solid month for stock markets with all the major indices recording positive returns. The Dow Jones Industrial Index had its best month since 2002 and the S&P 500 Index, Nasdaq Composite Index and Russell 2000 Index all recorded a fifth successive monthly gain, but were trumped by the Chinese Shanghai Composite Index that notched up seven consecutive positive months.

Stock market returns for the week ranged from top performers such as the Czech Republic (+8.7%), Kazakhstan (+8.5%), Turkey (+8.2%), Indonesia (+6.3%) and Kyrgyzstan (+5.8%) to Slovakia (-6.3%), Greece (-3.6%), Nepal (-3.0%), Ecuador (-2.2%) and Macedonia (-1.5%) at the other end of the scale.

The question we have been focused on for some time now is whether we end up with inflation, or deflation, and what that endgame looks like. It is one of the most important questions an investor must ask today, and getting the answer right is critical. This week, we have a guest writer who takes on the topic of the great experiment the Fed is now waging, which he calls The Great Reflation Experiment.

One of my favorite sources of information for decades has been and remains the Bank Credit Analyst. It has a long and
storied reputation. One of their enduring themes has been the debt super cycle. Investors who have paid attention to it have been served well. I am taking a little R&R this weekend, but I have arranged for my friend Tony Boeckh to stand in for me. Tony was chairman, chief executive, and editor-in-chief of Montreal-based BCA Research, publisher of the highly regarded Bank Credit Analyst up until he retired in 2002. He still likes to write from time to time, and we are lucky enough to have him give us his views on where we are in the economic cycles. Gentle reader, we are all graced to learn from one of the great economists and analysts of our times. Pay attention. Central bankers do. You can read his extensive bio at www.boeckhinvestmentletter.com and I will tell you how to get his letter free of charge at the end of this letter.
And, he told me to mention that his son Rob is now helping him write, so there is a double byline here. Now, let’s just jump in.

By Tony Boeckh and Rob Boeckh

The Crash of 2008/9 should be seen as yet another consequence of long-term, persistent US inflationary policies.
Inflation doesn’t stand still. It tends to establish a self-reinforcing cycle that accelerates until the excesses in money and credit become so extreme that a correction is triggered. The bigger the inflation, the bigger the correction. Once a dependency on credit expansion is well established, correcting the underlying imbalances becomes extremely difficult. Reflation has occurred after each major correction, and this one is proving no exception. Return to discipline in the current environment would be too painful and dangerous. Once on the financial roller coaster, it is very hard to get off. Moreover, the oscillations between peaks and valleys become increasingly large and unstable.

Policymakers, money managers, and most forecasters have argued that the crash was a “black swan” event, meaning
that it had an extremely low probability of occurrence. That is grossly misleading, as it implies that the crash was so far beyond the realm of normal probabilities that it was unreasonable to expect anyone to have foreseen it. That argument has been used to justify the widespread complacency that prevailed in the years leading up to the crash. Policymakers are still failing to recognize the systemic causes of the crash and seem to believe that enhanced regulation will prevent history from repeating. While it is true that regulators were asleep at the switch or looking the other way, they were not the cause.

The Debt Super Cycle

The real culprit is the US debt super cycle, which has operated for decades, mostly in a remarkably benign manner. The inflationary implications of the twin deficits (current account and fiscal), as well as the steady increase in private debt, have been moderated by the integration of emerging markets into the global economy. The massive increase in industrial output from China, India, and others has enabled persistent credit inflation in the US to occur with virtually no consequence to date (other than periodic asset price bubbles and shakeouts). How long the disinflationary impact of emerging-market productivity growth will persist and how long these nations will continue loading up on Treasuries, will be instrumental in determining the course that the Great Reflation will take.

Tougher regulation is surely appropriate, but it will not stop the next inflationary run-up unless the system is fixed. In the final analysis, newly minted money and credit must find a home somewhere.

My friend and colleague Janet Tavakoli sent me this scathing comment. She is one of the most respected analysts in the world of structured finance and risk. When I see Janet rant, I read. Also, 7/30/09 reply from Jim Rogers at bottom. Enjoy – Chris

In the early part of 2007, Meredith Whitney appeared on Cavuto on Business with Jim Rogers and opposed his viewpoint. She rated Citigroup “sector perform.” Rogers was short. By the end of October 2007, three other prominent analysts already had a sell on Citi; Whitney followed by rating it sector underperform and said Citigroup could trade in the low ‘30’s and would have to cut its dividend. The dividend cut was a good call. Rogers made it months earlier when he shorted the stock. It was too late to give an early warning about Citigroup’s toxic assets. Securitization had already ground to a halt, and everyone was taking losses. Citi hit $5 in January 2009, just as Rogers said it would.

According to Reuters, Whitney said she got “several death threats” as a result of her Citi call. The rumored death threats were widely reported. But who told the press about death threats? Security consultants advise the target of death threats not to discuss it, particularly not with the press. The threats were downgraded faster than Whitney downgraded Citigroup—a Fortuneinterview said she received “one death threat.” Whitney rated Bear Stearns perform and downgraded it to underperform on March 14, 2008 as it tumbled 53% in one day. Clues to Bear Stearns’ problems were publicly reported in May 2007 when the Everquest IPO became news, and CDOs from BSAM’s hedge funds landed on Bear Stearns’s balance sheet. Reportedly, Whitney hesitated Bear’s fateful week of March 2008 due to her perceived pressure over her Citi dividend call, but pressure or not, she was already too late.

Jim Rogers also warned about Lehman when Bear Stearns imploded in mid-March 2008, but Whitney continued to rate Lehman outperform. Whitney downgraded Lehman to “perform” at the end of March 2008—so much for taking a hint or issuing an early warning. Lehman went under September 2008.

I first took an interest when Whitney was billed as the woman who gave early warning about AIG, because she did not as far as I know. In August 2007, I challenged AIG’s earnings—specifically its failure to take losses on credit derivatives protecting “super senior” structures, the type of products on which we eventually paid out TARP money.

Bill Dunkelberg is currently a professor of economics at Temple University where he served as dean of the School of Business from 1987-95. Prior appointments were at Purdue, Stanford and the University of Michigan. He has served as the Chief Economist for the National Federation of Independent Business for 35 years, is the Chairman of…Read More

The July Chicago PMI was 43.4, about in line with expectations of 43 and up from 39.9 in June and it’s the highest level since the Sept ’08 reading of 55.9. New Orders remained below 50 but jumped 6.4 points to 48. Backlogs however fell 5.5 points to 32.1. Inventories remained extremely lean, falling to…Read More

> Initial Jobless Claims were 9k more than expected. But Continuing Claims were 103k less than expected. As we have regularly noted, Street spinmeisters ignore Continuing Claims when they are worse than expected but herald the rebound in the job market when they are better than expected. We noted almost two months ago that Continuing…Read More

Q2 GDP fell 1%, .5% better than expected but the breakdown was very mixed as NOMINAL GDP fell more than expected as the deflator rose just .2% vs expectations of a gain of 1%. If the deflator was in line, REAL GDP would have fallen 1.8%. Personal consumption dropped 1.2%, .7% more than the consensus…Read More

Today we’ll quantify to what extent the US economy is one step closer to ending the recession when Q2 GDP is expected out with a decline of 1.5%, the 4th Q in a row of contraction. Trade and inventories are the two components that will lead the slowing rate of decline as personal consumption, 70%…Read More

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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